Democrats are now threatening to go over the fiscal cliff on Jan. 1 if Republicans aren’t willing to agree to tax hikes for the wealthy. Technically, that means that the Bush tax cuts for everyone will expire, including ordinary middle-class Americans. But there’s also a way for Congress to apply the Bush tax cuts retroactively, although it wouldn’t be without its own complications, according to tax policy experts.
Even if legislators still haven’t come to a deal the fiscal cliff deadline, Congress could decide to restore the tax cuts so they would start Jan. 1. That’s especially likely to happen for the middle-class Bush tax cuts, which both parties support preserving through 2013. “That certainly works for taxes in 2013. It’s been done before for AMT patches and various other expired provisions,” says Donald Marron, director of the Tax Policy Center. Chad Stone, an economist at the Center on Budget and Policy Priorities, agrees: “It would be reasonable for people to expect that at least the middle class Bush tax cuts would eventually be restored at least another year. That would be done retroactively to January 1.”
There is one obvious speed bump, however: Although taxpayers don’t pay their 2013 taxes until 2014, employers do begin withholding federal income taxes from their employees income on January 1, Stone says. The IRS is required to issue new withholding tables for employers at the higher rates if there isn’t a deal by then. So employees would still get more taken out of their paychecks, starting in January, until Congress can come up with a deal. Legislators would have to adjust the withholding rates for the rest of 2013 if they want to undo the impact of taxmaggedon on taxpayers. They could also try to delay the new tax withholding rates from taking effect on Jan. 1 if it looks like a deal is imminent, although “it’s not clear that such steps would be feasible,” Stone adds.
So, technically speaking, legislators have a slightly more flexible time frame to come up with a deal than it may seem. Even if Congress makes the Bush tax cuts retroactive, the fiscal cliff could still slow down the economy if Americans skeptical that they’ll be spared slow consumer and business spending. “It would be much better to have the tax law nailed down much earlier, so the IRS and taxpayers would know law they should be administering and complying with,” says Marron.